Sunday, August 29, 2010

It Wasn't All Bush

Obama is the first President in memory that has refused to take ownership of the economy he inherited. Because of this, our current President has presided over a US economy were the American people continue to be unsure who is responsible and what is being done. Once they took power, FDR did not blame Hoover, nor did Reagan blame Carter; both took ownership and responsibility for economy from their inauguration forward. This inspires confidence and allows the President to define the present economy and his strategy for creating growth. Obama has done neither, except to blame the previous administration. We therefore are left up in the air wondering what it is exactly that we are supposed to "Blame Bush" for and what strategy Obama is using, besides increasing public dept and expanding entitlements. So lets take a moment to review exactly what we are "Blaming Bush" for and what Obama could be doing if he were to finally take ownership of the economy.

Most have heard something about the repeal of Glass-Steagall, a post Great Depression law that was passed in hopes of preventing another depression, and in many ways what also lead to our current problems. The repeal started as a Republican bill during the Clinton Administration in 1999. The proponents of the bill were Sen. Phil Gram(R-TX) and Rep. Jim Leach(R-IO), but by the time it emerged from it's conference committee it was very bi-partisan bill and Clinton signed it into law.

What really started the ball rolling on the mortgage bubble was Clinton's ex-Director of Management and Budget Franklin Raines. Raines took control of Fannie Mae in 1999 and instituted the American Dream Commitment program which started the pilot program of increasing sub-prime loans to get previously un-qualified and more minorities home loans. By 2004 Raines was raking in the dough but the numbers were not adding up. After Raines resigned in Dec 2004, it was determined he mis-stated over $6 billion in profits adding about $90 million to his bonuses. His penalty was to return about $7 million, but the sub-prime program started by Raines exploded after he left and the rest is history. Raines is now involved in an carbon trading Investment Company waiting for cap and trade to be voted in. Neither the Republicans or Democrats did much to stop the coming melt-down, but it was Democrats such as Barney Frank and Chris Dodd that were the most vocal defenders.

Our crisis however was one of credit. The basis of the credit crunch can be traced in my opinion to Ronald Reagan. The result of Carter Stagflation (a recession with high interest rates; not believed possible till then) caused lower debt and higher savings in the private sector. As interest rates fell and the economy boomed, but the effect was misapplied supply side economics. Now this was not President Reagan's intention. Reagan cut taxes across the board, but also raised the employer tax (ie Social Security) so the Social Security fund would be solvent in the future. When there was a significant budget deficit, Reagan made a deal with the Democrts that he would raise some taxes and they would reduce spending; Reagan did his part, but the Demicrats did not.  The effect on the national psyche, was actually Keynesian in nature, that with cheap money (low interest rates) the private sector could borrow their way to prosperity. This reduction in savings and excessive private debt help fuel the economy through the Bush 41 , Clinton and Bush 43 years. Much has been said of the Clinton budget surpluses, which right or wrong are mainly attributed to a lack of major military conflict during his presidency and a markedly reduced GDP, probably a result of increased taxes. The end result was an economy based on credit.

A simplistic definition of Keynesian theory: Keynes explanations of slumps ran something like this: in a normal economy, there is a high level of employment, and everyone is spending their earnings as usual. This means there is a circular flow of money in the economy, as my spending becomes part of your earnings, and your spending becomes part of my earnings. But suppose something happens to shake consumer confidence in the economy. Worried consumers may then try to weather the coming economic hardship by saving their money. But because my spending is part of your earnings, my decision to hoard money makes things worse for you. And you, responding to your own difficult times, will start hoarding money too, making things even worse for me. So there's a vicious circle at work here: people hoard money in difficult times, but times become more difficult when people hoard money. The cure for this, Keynes said, was for the central bank to expand the money supply. By putting more bills in people's hands, consumer confidence would return, people would spend, and the circular flow of money would be reestablished. ( You will notice not once was there a mention of reducing unemployment, that's because Keynesian economics does not key into unemployment, only increasing the money flow. But no time in the history of economics has a private economy been so indebted. The Keynesians have no plan to stop people from paying off debt, rather than re-circulating money.

Another inherent flaw in Keynesian theory is the belief in cheap money; that it doesn't matter if you can't repay a loan as long as you can afford the interest payments. Sound familiar? When Keynesians say "expanding the money supply", they mean low interest loans and subsidizing private industry usually with large construction projects. The problem is there is no mechanism in Keynesian theory to ever actually pay back the loans and when the construction jobs ends, so does the temporary employment. As long as the Federal reserve keeps interest rates low, there will also be no incentive to save money. This reliance on borrowing cheap money has led to our current situation where business must borrow to stay in business. It is like you needing to borrow rent money, knowing you will have the money next month. You pay the rent with the borrowed money but when the next month's rent comes due, you must use what ever money has come in to pay off last months loan and then take out another loan for this month; you can never get ahead and if the bank stops loaning you're dead in the water. Government on the other hand, just keeps taking out interest only loans.

However bad the sub-prime meltdown was, and it was bad, was made ten times worse by side bets (or Credit Default Swaps) made by the investment banks like Leman Bros, AIG and of course Goldman Sachs. For every sub-prime mortgage that was loaned out, there were about 40-50 of these made up side bets made. After the meltdown, US Banks had assets, originally valued at about $1 trillion, who's value could not be determined (i.e. toxic), which basically meant they couldn't lend any money and businesses almost came to a stand still. The government first decided to just buy (or insure these toxic assets, because unlike the banks, the Fed can just hold onto them until their value can be established later. This was done during the Saving and Loan crisis of the 1980's and the Federal Government actually made money when the S&L assets were eventually sold. Unfortunately the players in all this, Henry (Hank) Paulson, Ben Bernanke, Timothy Geithner, all alumni from Goldman Sachs, knew the real danger to the banks was from the outstanding Credit Default Swaps, whose outstanding debt to the banks could be as high as $40 trillion. Therefore the expanded Troubled Asset Relief Program (TARP) money,  ($1.2 Billion) ended up being distributed via AIG to US (including Goldman Sachs) and European banks to cover some of these outstanding derivatives. So instead of loosing up money to make more loans, the banks just made good with themselves.

The recession we are seeing now is the result of business holding back until they can once again run their business month to month without having to borrow money. This process is pretty much complete, but before they start hiring again, and borrowing to expand, they want to know what the new government programs and taxes are going to cost them. The only offering the Obama economists are offering is to make it easier to borrow money, this is the Keynesians concept of expanding the money supply. But until business knows what is coming down the pike, they are going to wait. Add to this Obama wanting to raise taxes by letting the Bush tax cuts expire and we are so stuck.

As a final caveat, one should look at Bush's spending compared to Obama. It is difficult to understand exactly how much $700 billion or $800 billion really is. The CBO recently released a study, that shows that Obamas stimulus @ $862 billion, cost more than 8 years of the Iraqi war under Bush. Further, although Bush created a new high in deficit spending adding $2.5 billion of debt in eight years. In 2009 Bush submitted a budget with a $487 billion deficit, but Obama added another $700 billion resulting in a $1.2 trillion deficit (the left wing media usually charges Bush with the entire amount).  TARP was a two part process. Bush distributed $267 billion in 2008 and the Obama Administration distributed some $151 billion in 2009. Then, because banks and Wall Street firms repaid a net $110 billion in TARP funds in 2010, Obama claimed credit for cutting spending by that much.The combination of TARP lending in one year and much of that money being paid back in the next makes Obama's spending record for 2010 look $261 billion thriftier than it really was. This also means of the $700 billion TARP loans guarantees that were added to the 2009 Bush deficit, only $418 billion were ever disbursed of which $405 billion was repaid, but because the repaid Bush TARP money was claimed by Obama as cost saving, rather than returned to the Treasury, it continued to be counted as Bush deficit spending. Add the 2010 deficit of an estimated $1.3-1.4 trillion and Obama will have raised the national debt by over $2.5 trillion, matching Bush's 8 year debt in only 2 years. Obama and the left say these deficits are necessary to reverse to damage done by Bush, but if that is so, why don't they actually change the policies as well? 

While Bush claimed to believe in supply side economics (lower taxes and cut spending), with the exception of his tax cuts, he was really a Keynesian with his spending and $152 million stimulus. While Bush was the President of note as the sub-prime bubble became critical, the seeds sewn for this recession and were planted at least as far back as the Clinton Administration. Bush even did try to regulate Fannie Mae and the other mortgage GSEs in 2003 New Agency To Oversee Freddie Mac and Fannie May, which failed. But now we see the new Financial Reform Law, still does nothing to reform the regulations of Fannie and Freddie. As usual the politicians that created the problem tell us they are the only ones that can fix it. There is also the reminder discussed by Thomas Sowell, "No President of the United States can create either a budget deficit or a budget surplus. All spending bills originate in the House of Representatives and all taxes are voted into law by Congress. Democrats controlled both houses of Congress before Barack Obama became president. The deficit he inherited was created by the Congressional Democrats, including Senator Barack Obama, who did absolutely nothing to oppose the runaway spending. He was one of the biggest of the big spenders. The last time the federal government had a budget surplus, Bill Clinton was president, so it was called 'the Clinton surplus.' But Republicans controlled the House of Representatives, where all spending bills originate, for the first time in 40 years. It was also the first budget surplus in more than a quarter of a century."

The direction I believe we need to go is what Germany is doing; read this Op-Ed piece by David Brooks and see if you don't agree The Parent Model . If any of what I have tried to explain in the article runs true, then hopefully you will realize that it's doesn't matter if you blame Bush43 as the President of record when the economy collapsed, as long as we change they way we are doing business and that is not happening.

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